November 10, 2016

Energy Storage – Is the regulation ready for what’s in store?

The Challenge

On 4 November 2016, the Paris Agreement on climate change entered into force. The Agreement commits the global community to hold global warming to no more than 2°C above pre-industrial levels. If the UK is to play its part, it will have to move away from the cheap, but polluting gas generation on which it currently relies. With the recent news that global atmospheric carbon dioxide levels averaged 400ppm over the course of a year for the first time in 2015, it is clear that action is needed now. Both nuclear and renewable technologies are likely to have a part to play in the decarbonisation of the UK’s energy production but each has disadvantages: nuclear energy is secure but expensive; renewable energy is increasingly affordable but less secure. Furthermore, nuclear production is not dispatchable, so is unable to respond when renewable production is low. By introducing flexibility into the system, storage may offer a solution to the energy trilemma and many companies are now looking at it as a major growth area. However, as is so often the case, the regulation has been slow to catch up with technological developments.

Barriers to storage uptake

There are a number of barriers which prevent the mass uptake of storage. The current regulatory framework was not designed with widespread and integrated storage deployment in mind and one of the biggest obstacles facing companies looking to invest in storage is the lack of any distinct definition of storage within it. When the current framework was being designed, storage was an insignificant part of the energy landscape. A small amount of pumped hydro did exist but given its ability to compete with generation in the provision of bulk energy and balancing services, it was convenient to simply treat it as a form of generation. However the characteristics of pumped hydro are very different from more modern storage technologies which offer a far wider range of services. In ignoring this and in ignoring the fact the storage does not create net positive flows of electricity, the inclusion of storage within the generation definition is no longer appropriate.

This mislabelling has a number of consequences. It has implications for the ownership and operation of storage assets, which is discussed below. In addition, given the variety of storage technologies with a plurality of characteristics, it also creates uncertainty for developers as to how their specific projects will be treated. Finally it creates a disincentive to scale. Storage assets which are smaller than 50MW are exempt from the requirement to have a licence. However larger projects will need to apply for a licence which is ill suited to the actual activity being licenced. This represents a significant administrative and cost burden. Thus, if storage is to become an integral part of the electricity landscape, ensuring that it is properly defined within the regulatory framework seems a sensible place to start.

Prohibition on ownership by TSOS and operation by DNOs

The characterisation of storage as a form of generation has an impact on who can own and operate storage assets. The liberalisation of the electricity market required the splitting up of those segments which are natural monopolies (transmission and distribution) from those which are open to competition (generation and supply). Transmission System Operators (TSOs) are prohibited from owning licenced generation assets and Distribution Network Operators (DNOs) must guarantee the operational independence of any licenced generation assets they own through stringent legal, accounting and functional unbundling requirements. Since storage is classed as a form of generation, this means that TSOs and DNOs cannot own or operate any generating asset which requires a licence. Whilst they may own storage assets that do not require a licence (i.e. those that a smaller than 50MW), this represents an obstacle to the development of large scale storage.

A further obstacle to the development of large scale storage comes from the de minimis restrictions placed on DNOs. DNOs may not generate more than 2.5% of their revenue from non-distribution activities or make investments in non-distribution activities that exceed on an aggregate basis 2.5% of their issued share capital, share premium and consolidated reserves. While the current scale of storage does not come close to threatening these de minimis restrictions, if storage is to become an integral part of the electricity market, it may soon become an issue.

These barriers to entry on TSOs and DNOs prevent the organisations that are best placed to manage the smart grid from acquiring the assets to do so. While the ownership restrictions clearly represent an opportunity for independent storage operators, they also present an obstacle to widespread storage uptake. DNOs, in particular, are better able to exploit storage’s potential by optimising storage assets to balance the system. They also have the scale, technical expertise and financial clout to develop large scale storage projects. Therefore the restrictions on DNOs and TSOs pose a significant obstacle to integrating storage into the UK’s electricity sector.

Double Charging

Another inhibitor to development of storage is the risk of incurring double charges. Transmission Network Use of System (TNUoS) charges and Distribution Network Use of System (DSUoS) charges are levied to recoup the cost of maintaining and operating the transmission and distribution networks. TNUoS charges are only levied on assets over 100MW, which excludes most storage assets. However DSUoS charges apply to all distribution network users and most storage is likely to be embedded in distribution. As storage assets take electricity off the network when charging and put electricity onto the network when discharging, they are liable to pay DSUoS charges twice. Whilst, not all of this represents a double charge, since some of the import charges can be recovered on export, it does result in a cost which fails to reflect the balancing contribution storage makes to the system. If the government wants to incentivise the uptake of storage, reforming the TNUoS and DSUoS charges is another area it will need to look at.

Subsidy costs

The UK maintains various subsidy regimes aimed at supporting the deployment of low carbon generation. However, perversely, these regimes could present a barrier to the deployment of storage as the treatment of storage under the regimes is far from clear and may have adverse consequences. One example is the Climate Change Levy (CCL). Under the CCL, a levy is charged on electricity supplied to industrial and commercial consumers. Whether an individual storage asset is treated as an “industrial and commercial consumer” under the CCL will depend on its individual characteristics and whether it is able to benefit from one of the exemptions. This is likely to require detailed assessment in each case. If the CCL does apply to a storage asset, then the charge will be levied both on electricity entering and electricity leaving the storage facility. This will have the effect of increasing the price of electricity which has been through the facility.

The Renewables Obligation (RO), Feed-in Tariff (FIT) and Contract for Difference (CfD) regimes also each have the potential to disincentivise the uptake of storage. In essence the RO, FIT and CfD regimes each work by shifting money from licenced suppliers to renewable generators, with the suppliers’ contribution based on their size and market share. The RO works by obliging suppliers to take a certain proportion of their supply from eligible renewable generators. The CfD regime works by paying a fixed strike price to renewable generators which is recovered from suppliers in proportion to their market share. As part of the FIT regime, a reconciliation process is run, known as “levilisation”, with suppliers contributing to the levilisation pot based on the size of their supply. Therefore under each of these subsidy regimes, suppliers have an incentive to reduce their supply by as much as possible.

If storage is classed as a type of end-use consumption under each of the regimes, then supplies made to storage facilities will count towards a supplier’s total supply. When the supplier takes the electricity out of storage and onsells to final consumers, this will also count towards a supplier’s total supply. Thus electricity which has been through a storage facility would count twice towards a supplier’s total supply: once when it is supplied to the storage facility and again when it is supplied to a final customer. Given the implications this would have for a supplier’s obligations under the RO, FIT and CfD regimes, this creates a disincentive to suppliers dealing with storage facilities.

The treatment of storage under each of these subsidy regimes is far from clear and the administrative burden of working out how a particular project should be treated represents a significant barrier in itself. This could be solved by classing storage as something other than a supply to an end-user. This is logical given the vital role that storage plays in facilitating renewable generation, the very thing the subsidies are designed to incentivise.

Conclusion

Greater uptake of storage will be essential if the UK is to achieve a sustainable, low cost and secure energy future. Unfortunately the complex legislation and subsidies regimes which regulate the energy sector were not designed with a fully integrated storage element in mind. This is clearly demonstrated by the absence of any specific definition of storage within the Electricity Act 1989. This omission has created regulatory uncertainty and a number of unintended consequences which currently present significant obstacles to the introduction of storage on a large scale. Meanwhile subsidies which have been successful in increasing renewable and low-carbon generation are designed in such a way that they disincetivise suppliers from dealing with storage facilities. Thus the very policies which aim to move the UK towards a low-carbon future are having a negative impact on one of the key areas necessary to make that future a reality.

One of storage’s great advantages is its flexibility, with different types of assets able to offer different types of services. However this flexibility poses a challenge in itself. Given the complexities and uncertainties, each asset will need to be considered on a case-by-case basis to determine how it fits within the current regime. The Government should act quickly to introduce the necessary legislation to clarify the regulatory status of storage so it can play its proper role in the UK power market.